# Bancorp 34, Inc.: Form 10-Q for the period ended Sep 30, 2017

- Company: [Bancorp 34, Inc.](/companies/bctf.md) (CIK 1668340)
- Form: 10-Q
- Filed: 2017-11-14
- Accepted by EDGAR: Nov 14, 2017, 11:41 ET
- Period: 2017-09-30
- Accession: 0001437749-17-019265
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1668340/000143774917019265/bctf20170930_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1668340/000143774917019265/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2017-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2017-07-01 to 2017-09-30 | $610.4k | us-gaap:InterestExpense |
| Interest expense | 9 months, 2017-01-01 to 2017-09-30 | $1.6m | us-gaap:InterestExpense |
| Income tax | 3 months, 2017-07-01 to 2017-09-30 | $487.2k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2017-01-01 to 2017-09-30 | $491.3k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2017-07-01 to 2017-09-30 | $811.7k | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2017-01-01 to 2017-09-30 | $952.1k | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2017-07-01 to 2017-09-30 | $0.25 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2017-01-01 to 2017-09-30 | $0.29 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2017-07-01 to 2017-09-30 | $0.25 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2017-01-01 to 2017-09-30 | $0.29 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2017-07-01 to 2017-09-30 | 3,265,521 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2017-01-01 to 2017-09-30 | 3,265,032 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2017-01-01 to 2017-09-30 | $10.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2017-01-01 to 2017-09-30 | $415.6k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2017-09-30 | $34.9m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2017-09-30 | $363.2m | us-gaap:Assets |
| Total liabilities | at 2017-09-30 | $311.3m | us-gaap:Liabilities |
| Shareholders' equity | at 2017-09-30 | $51.9m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 49,955 characters.

Management’s discussion and analysis of financial condition at September 30, 2017 and December 31, 2016 and results of operations for the three and nine months ended September 30, 2017 and 2016 is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Unaudited Consolidated Financial Statements and the notes thereto, appearing in Part 1, Item 1 of this report.

### CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this document that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (referred to as the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (referred to as the Securities Exchange Act), and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. You can identify these statements from the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” "tend," “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including among other things, changes in general economic and business conditions. Because of these and other uncertainties, Bancorp 34’s actual results, performance or achievements, or industry results, may be materially different from the results indicated by these forward-looking statements. You should not place undue reliance on any forward-looking statements, which speak only as of the dates on which they were made. Bancorp 34 is not undertaking an obligation to update these forward-looking statements, even though its situation may change in the future, except as required under federal securities law. Bancorp 34 qualifies all of its forward-looking statements by these cautionary statements.

### Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, the evaluation of other-than-temporary impairment of investment securities, the valuation of and our ability to realize deferred tax assets and the measurement of fair values of financial instruments.

***Allowance for Loan Losses.*** The allowance for loan losses is calculated with the objective of maintaining an allowance necessary to absorb credit losses inherent in the loan portfolio. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral.

We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish an allowance for loan losses. The allowance for loan losses is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of the probable losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date. Our evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

The allowance for loan losses consists primarily of specific allocations and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral, including adjustments for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting and payment history. We also analyze delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance. The principal assumption used in calculating the allowance for loan losses is the estimate of loss for each risk rating. Actual loan losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results.

***Other-Than-Temporary Impairment.*** In estimating other-than-temporary impairment of investment securities, securities are evaluated on at least a quarterly basis, to determine whether a decline in their value is other-than-temporary. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether or not we intend to sell or expect that it is more likely than not that we will be required to sell the investment security prior to an anticipated recovery in fair value. Once a decline in value for a debt security is determined to be other than temporary, the other-than-temporary impairment is separated in (a) the amount of total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to credit loss is recognized in earnings. The amount of other-than-temporary impairment related to other factors is recognized in other comprehensive income (loss).

***Valuation of Deferred Tax Assets.*** In evaluating our ability to realize deferred tax assets, management considers all positive and negative information, including our past operating results and our forecast of future taxable income. In determining future taxable income, management utilizes a budget process that makes business assumptions and the implementation of feasible and prudent tax planning strategies. We also utilize a monthly forecasting tool to incorporate activity throughout the calendar year. These assumptions require us to make judgments about our future taxable income that are consistent with the plans and estimates we use to manage our business.

***Fair Value Measurements.*** Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. A three-level of fair value hierarchy prioritizes the inputs used to measure fair value:

- Level 1 – Quoted prices in active markets for identical assets or liabilities; includes certain U.S. Treasury and other U.S. Government agency debt that is highly liquid and actively traded in over-the-counter markets.
- Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
- Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

### Average Balance Sheets

The following tables set forth average balances, yields and costs, and certain other information for the periods indicated. Tax-equivalent yield adjustments have not been made for tax-exempt securities, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income.

*(Dollars in thousands)*

| Interest-earning assets: | Three Months Ended September 30, 2017 Average Outstanding Balance | Interest | Yield/ Rate (1) | 2016 Average Outstanding Balance | Interest | Yield/ Rate (1) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $285,425 | $3,972 | 5.52% | $236,806 | $3,334 | 5.60% |
| Interest-earning deposits | 7,858 | 28 | 1.41% | 17,833 | 22 | 0.49% |
| Securities | 27,943 | 129 | 1.83% | 33,268 | 114 | 1.36% |
| Federal Home Loan Bank stock | 3,203 | 14 | 1.73% | 2,373 | 2 | 0.34% |
| Other | 383 | - | 0.00% | 383 | - | 0.00% |
| Total interest-earning assets | 324,812 | 4,143 | 5.06% | 290,663 | 3,472 | 4.75% |
| Noninterest-earning assets | 23,568 |  |  | 19,461 |  |  |
| Total assets | $348,380 |  |  | $310,124 |  |  |
| **Interest-bearing liabilities:** |  |  |  |  |  |  |
| Checking, money market and savings accounts | $129,785 | 270 | 0.83% | $129,742 | 233 | 0.71% |
| Time deposits | 63,061 | 153 | 0.96% | 63,985 | 135 | 0.84% |
| Total deposits | 192,846 | 423 | 0.87% | 193,727 | 368 | 0.76% |
| Advances from FHLB of Dallas | 63,554 | 187 | 1.16% | 49,882 | 74 | 0.59% |
| Total interest-bearing liabilities | 256,400 | 610 | 0.94% | 243,609 | 442 | 0.72% |
| Non-interest bearing deposits | 36,209 |  |  | 32,378 |  |  |
| Non-interest bearing liabilities | 3,747 |  |  | 2,992 |  |  |
| Total liabilities | 296,356 |  |  | 278,979 |  |  |
| Stockholders' equity | 52,024 |  |  | 31,145 |  |  |
| Total liabilities and stockholders' equity | $348,380 |  |  | $310,124 |  |  |
| Net interest income |  | $3,533 |  |  | $3,030 |  |
| Net interest rate spread (2) |  |  | 4.12% |  |  | 4.03% |
| Net interest-earning assets (3) | $68,412 |  |  | $47,054 |  |  |
| Net interest margin (4) |  |  | 4.32% |  |  | 4.15% |
| Average interest-earning assets to average interest-bearing liabilities |  |  | 126.68% |  |  | 119.32% |

(1) Yield/rate for the three-month periods have been annualized.

(2) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.

(3) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(4) Net interest margin represents net interest income as a percentage of average total interest-earning assets.

*(Dollars in thousands)*

| Interest-earning assets: | Nine Months Ended September 30, 2017 Average Outstanding Balance | Interest | Yield/ Rate (1) | 2016 Average Outstanding Balance | Interest | Yield/ Rate (1) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $270,560 | $11,224 | 5.55% | $219,646 | $9,470 | 5.76% |
| Interest-earning deposits | 11,613 | 90 | 1.04% | 12,993 | 48 | 0.49% |
| Securities | 29,523 | 404 | 1.83% | 30,330 | 356 | 1.57% |
| Federal Home Loan Bank stock | 3,260 | 37 | 1.52% | 1,573 | 7 | 0.59% |
| Other | 383 | 16 | 5.59% | 383 | 8 | 2.79% |
| Total interest-earning assets | 315,339 | 11,771 | 4.99% | 264,925 | 9,889 | 4.99% |
| Noninterest-earning assets | 22,333 |  |  | 19,446 |  |  |
| Total assets | $337,672 |  |  | $284,371 |  |  |
| **Interest-bearing liabilities:** |  |  |  |  |  |  |
| Checking, money market and savings accounts | $127,217 | 760 | 0.80% | $123,524 | $673 | 0.73% |
| Time deposits | 62,212 | 430 | 0.92% | 68,555 | 425 | 0.83% |
| Total deposits | 189,429 | 1,190 | 0.84% | 192,079 | 1,098 | 0.76% |
| Advances from FHLB of Dallas | 56,564 | 433 | 1.02% | 23,670 | 99 | 0.56% |
| Total interest-bearing liabilities | 245,993 | 1,623 | 0.88% | 215,749 | 1,197 | 0.74% |
| Non-interest bearing deposits | 36,758 |  |  | 35,253 |  |  |
| Non-interest bearing liabilities | 3,358 |  |  | 2,721 |  |  |
| Total liabilities | 286,109 |  |  | 253,723 |  |  |
| Stockholders' equity | 51,563 |  |  | 30,648 |  |  |
| Total liabilities and stockholders' equity | $337,672 |  |  | $284,371 |  |  |
| Net interest income |  | $10,148 |  |  | $8,692 |  |
| Net interest rate spread (2) |  |  | 4.11% |  |  | 4.24% |
| Net interest-earning assets (3) | $69,346 |  |  | $49,176 |  |  |
| Net interest margin (4) |  |  | 4.30% |  |  | 4.38% |
| Average interest-earning assets to average interest-bearing liabilities |  |  | 128.19% |  |  | 122.79% |

(1) Yield/rate for the nine-month periods have been annualized.

(2) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.

(3) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(4) Net interest margin represents net interest income as a percentage of average total interest-earning assets.

### Comparison of Financial Condition at September 30, 2017 and December 31, 2016

Cash and cash equivalents increased $18.5 million, or 112.6%, to $34.9 million at September 30, 2017 from $16.4 million at December 31, 2016. The increase is due to retaining enough funds to pay off a $25.0 million FHLB advance that matures in October.

Loans held for investment increased $25.2 million, or 10.3%, to $269.1 million at September 30, 2017 from $243.9 million at December 31, 2016, due to organic growth. The increase was primarily due to an increase in commercial real estate loans, which increased $24.6 million, or 12.6%, to $220.4 million at September 30, 2017 from $195.8 million at December 31, 2016. During the nine months ended September 30, 2017, commercial real estate loans increased to 81.6% of the gross loan portfolio from 80.0%, while one- to four-family residential real estate loans decreased to 11.2% of the portfolio from 12.2%. The residential mortgage loan portfolio experienced natural run-off as the Bank continued to focus on the secondary mortgage lending program whereby new loans are originated and sold for fee income as opposed to being held in the portfolio.

Loans held for sale at September 30, 2017 and December 31, 2016 totaled $10.5 million and $14.2 million, respectively, consisting entirely of residential mortgage loans. We currently sell a significant majority of our residential mortgage loans in the secondary market. The balances at any date vary based upon the timing and volume of loan originations and sales.

Available for sale securities decreased $4.8 million, or 15.2%, from $31.5 million to $26.7 million during the nine months ended September 30, 2017, due to normal payments in the portfolio.

Total deposits increased $15.6 million, or 7.0%, to $240.1 million at September 30, 2017 from $224.5 million at December 31, 2016. The increase included a $904,000, or 2.5% increase in non-interest bearing demand accounts, $7.6 million, or 6.1%, increase in savings and NOW deposits, and $7.1 million, or 11.1%, increase in time deposits. The increase in time deposits includes $10.0 million in brokered deposits originated in late September 2017 with $5.0 million at a rate of 1.75% maturing in 18 months and $5.0 million at a rate of 1.90% maturing in 30 months.

Borrowings, consisting solely of FHLB advances, increased $17.0 million, or 34.0%, to $67.0 million at September 30, 2017 from $50.0 million at December 31, 2016.

Total stockholders’ equity increased $1.1 million or 2.2%, to $51.9 million at September 30, 2017 from $50.8 million at December 31, 2016. The growth was due primarily to net income for the nine-month period of $952,000.

### Comparison of Operating Results for the Three Months Ended September 30, 2017 and 2016

***General.*** Net income was $812,000 for the three months ended September 30, 2017 and $228,000, or 39.1%, more than net income of $584,000 for the three months ended September 30, 2016. Pre-tax income was $1.3 million for the three months ended September 30, 2017 and $611,000 for the three months ended September 30, 2016. The provision for income taxes for the three months ended September 30, 2017 was $487,000 compared to $27,000 for the similar period in 2016. In 2016 we carried a 100% valuation reserve against our net deferred tax assets and had net operating loss carryforwards available to offset current tax liabilities.

***Interest Income.*** Interest income increased $671,000, or 19.3%, to $4.1 million for the three months ended September 30, 2017 from $3.5 million for the three months ended September 30, 2016. The increase was due to a $34.1 million, or 11.7%, increase in average interest-earning assets and an improvement in asset mix as loans, our highest yielding assets, increased to 87.9% of average interest-earning assets from 81.5% of average interest-earning assets. The yield on average interest-earning assets increased 31 basis points to 5.06% for the three months ended September 30, 2017 from 4.75% for the three months ended September 30, 2016. Interest and fees on loans increased $638,000, or 19.1%, to $4.0 million for the three months ended September 30, 2017, from $3.3 million for the three months ended September 30, 2016. Interest and fees on loans increased due primarily to a $48.6 million, or 20.5%, increase in average loan balances, due to organic growth, partially offset by an eight basis point decrease in yield. The average balance of securities decreased $5.3 million to $27.9 million for the three months ended September 30, 2017, compared to $33.3 million for the three months ended September 30, 2016, and the average yield increased from 1.36% to 1.83% for the three months ended September 30, 2016 and 2017, respectively.

***Interest Expense.*** Interest expense increased $168,000, or 38.0%, to $610,000 for the three months ended September 30, 2017 from $442,000 for the three months ended September 30, 2016. The increase was the result of an increase in interest expense on borrowings, which increased $113,000 to $187,000 for the three months ended September 30, 2017 from $74,000 for the three months ended September 30, 2016. Average interest-bearing deposits for the three months ended September 30, 2017 were $192.8 million, representing an $881,000, or 0.5%, decrease compared to average interest-bearing deposits of $193.7 million for the three months ended September 30, 2016. The average rate paid on interest-bearing deposits was 0.87% for the three months ended September 30, 2017 compared to 0.76% for the similar 2016 period.

The $113,000 increase in interest expense on borrowings was due to a $13.7 million increase in average balances and a 57 basis point increase in average rates paid. Borrowings were primarily used to fund loans held for sale in the first six months of 2016. Beginning in the third quarter of 2016 we also began to borrow to fund portfolio loan growth. The 57 basis point increase in average rates paid on FHLB borrowings was partially due to gradual Federal Funds target rate increases affecting our short-term borrowings and the addition of two longer term FHLB advances later in 2016. The first Federal Funds rate increase since 2008 was a 25 basis point increase announced in mid-December 2015. Short term borrowing rates continued to gradually increase after that date with 25 basis point increases in December 2016 and March and June 2017. In the second half of 2016 we added $20.0 million in long-term borrowings consisting of $10.0 million in two-year and $10.0 million in four-year fixed rate advances, averaging 1.11%, to lock in those rates in anticipation of further market rate increases.

Interest paid on checking, money market and savings accounts increased $37,000, or 18.5%, to $270,000 for the three months ended September 30, 2017 from $233,000 for the three months ended September 30, 2016. The average rate we paid on such deposit accounts increased 12 basis points to 0.83% for the three months ended September 30, 2017 from 0.71% for the three months ended September 30, 2016 and the average balance increased $43,000 or 0.03%, to $129.8 million for the three months ended September 30, 2017 from $129.7 million for the three months ended September 30, 2016. The average rates we pay on these accounts is considerably higher in our Arizona market.

Interest on time deposits increased $18,000 to $153,000 for the three months ended September 30, 2017 from $135,000 for the three months ended September 30, 2016. The increase in expense was primarily due to a 12 basis point increase in the average rate paid on time deposits to 0.96% for the three months ended September 30, 2017 from 0.84% for the three months ended September 30, 2016, partially offset by the effect of a $924,000, or 1.4%, decrease in average balances.

***Net Interest Income.*** Net interest income increased $503,000, or 16.6%, to $3.5 million for the three months ended September 30, 2017 from $3.0 million for the three months ended September 30, 2016, as a result of an increase in the balance of net interest-earning assets and a nine basis point increase in net interest rate spread. Our average net interest-earning assets increased by $21.4 million, or 45.4%, to $68.4 million for the three months ended September 30, 2017 from $47.1 million for the three months ended September 30, 2016, due primarily to organic growth. Our net interest rate spread increased by nine basis points to 4.12% for the three months ended September 30, 2017 from 4.03% for the three months ended September 30, 2016. Our cost of borrowings increased to 1.16% for the quarter ended September 30, 2017 from 0.59% for the quarter ended September 30, 2016 due to the increase in short-term interest rates following the 25 basis point increases in the target Federal Funds rate in December 2016, March 2017, and June 2017.

***Provision for Loan Losses.*** Provisions for loan losses are charged to operations to establish an allowance for loan losses at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. If the allowance for loan losses is larger than necessary, we post a negative provision as a benefit to earnings. In evaluating the level of the allowance for loan losses, management analyzes several qualitative loan portfolio risk factors including but not limited to, charge-off history over a relevant period, changes in management or underwriting policies, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower and results of internal and external loan reviews.

See “Asset Quality - Allowance for Loan Losses” for additional information.

After an evaluation of these factors, we recorded a provision for loan losses of $150,000 for the three months ended September 30, 2017, compared to $155,000 for the three months ended September 30, 2016. In the three months ended September 30, 2017, the allowance for loan losses grew $147,000 or 5.0%, and gross loans held for investment grew $4.5 million, or 1.7%.

To the best of our knowledge, at September 30, 2017 we have recorded all loan losses that are both probable and reasonable to estimate as of September 30, 2017. However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for loan losses. In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, will periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on its judgments about the recoverability of our loan balances based upon information available to it at the time of its examination.

***Noninterest Income.*** Noninterest income increased $327,000, or 9.6%, to $3.7 million for the three months ending September 30, 2017 compared to $3.4 million for the three months ended 2016.

Gain on sale of loans increased $316,000, or 9.8%, to $3.6 million for the three months ended September 30, 2017 from $3.2 million for the three months ended September 30, 2016.

During the three months ended September 30, 2017, we sold $72.7 million of mortgage loans and recognized gains of $3.5 million compared to $79.1 million of mortgage loan sales during the three months ended September 30, 2016 for gains of $2.9 million. Mortgage sales gain premiums vary from period to period based upon the mix of government Federal Housing Administration (FHA) and Veterans Administration (VA) loans to conventional loans, geographic markets and market interest rates, specifically 10-year U.S. Treasury rates. Sales gains include fair value adjustments for interest rate lock commitments and loans held for sale. In September 2017 we began originating and selling mortgage loans under mandatory delivery sales commitments in an effort to realize greater sales gains, since loan sales under mandatory delivery contracts generally realize greater prices than loans sold under best efforts agreements. We also began entering into counterparty trades with similar notional amounts designed to react inversely to market interest rate movements to reduce our interest rate risk on mandatory delivery loans. The implementation of those activities represented $668,000 of the gain on sale of loans for the three months ended September 30, 2017.

During the three months ended September 30, 2017, we sold $491,000 of SBA loans for a gain of $31,000, compared to $3.2 million of SBA loan sales during the three months ended September 30, 2016 for gains of $62,000.

***Noninterest Expense.*** Noninterest expense increased $147,000, or 2.6%, to $5.8 million for the three months ended September 30, 2017 from $5.7 million for the three months ended September 30, 2016 due primarily to an increase in salaries and benefits and occupancy. The salaries and benefits increases were primarily related to the expansion of our mortgage banking operations. The occupancy increase included increases in repairs and maintenance, depreciation and building leases. Average assets for the quarter ended September 30, 2017 were 12.3% greater than for the quarter ended September 30, 2016.

***Income Tax Expense.*** Income tax expense was $487,000 and $27,000 for the quarters ended September 30, 2017 and 2016, respectively. The Company had net operating loss carry-forwards from prior periods which offset income for the quarter ended September 30, 2016 and a 100% reserve against deferred tax assets; therefore, 2016 income tax expense consisted only of Federal alternative minimum tax and state tax expense. In December 2016 the reserve against deferred tax assets was removed and tax expense starting with the first quarter of 2017 was recorded at more common effective tax rates.

### Comparison of Operating Results for the Nine Months Ended September 30, 2017 and 2016

***General.*** We had net income of $952,000 for the nine months ended September 30, 2017, compared to net income of $1.1 million for the nine months ended September 30, 2016. Results in the first nine months of 2017 were negatively affected by higher compensation, primarily in the mortgage banking operation, $449,000 in increased income tax expense and a $244,000 larger provision for loan losses due to more rapid loan growth compared to the nine months ended September 30, 2016.

***Interest Income.*** Interest income increased $1.9 million, or 19.0%, to $11.8 million for the nine months ended September 30, 2017 from $9.9 million for the nine months ended September 30, 2016. The increase was due to a 19.0% increase in average interest-earning assets while yield remained unchanged. Loans, our highest yielding asset, increased from 82.9% to 85.8% of average interest-earning assets. Interest and fees on loans increased $1.8 million, or 18.5%, to $11.2 million for the nine months ended September 30, 2017, from $9.5 million for the nine months ended September 30, 2016. Interest income on loans increased due primarily to a 23.2% increase in average loan balances, due to organic growth, partially offset by a 21 basis point decrease in average yield. The average balance of securities decreased $807,000, or 2.7%, to $29.5 million for the nine months ended September 30, 2017, compared to $30.3 million for the nine months ended September 30, 2016 and the average yield increased 26 basis points.

***Interest Expense.*** Interest expense increased $426,000, or 35.6%, to $1.6 million for the nine months ended September 30, 2017 from $1.2 million for the nine months ended September 30, 2016. The increase was caused by an increase in interest expense on borrowings, which increased $334,000 to $433,000 for the nine months ended September 30, 2017 from $99,000 for the nine months ended September 30, 2016. Average interest-bearing deposits for the nine months ended September 30, 2017 were $189.4 million, representing a $2.7 million, or 1.4%, decrease compared to average interest-bearing deposits of $192.1 million for the nine months ended September 30, 2016. The average rate paid on interest-bearing deposits was 0.84% for the nine months ended September 30, 2017 compared to 0.76% for the 2016 period.

The $334,000 increase in interest expense on borrowings was due to a $33.0 million, or 139.0%, increase in average balances and a 46 basis point increase in average rates paid. Borrowings were primarily used to fund loans held for sale in the first six months of 2016. Beginning in the third quarter of 2016 we also began to borrow to fund portfolio loan growth. The 46 basis point increase in average rates paid on FHLB borrowings was partially due to gradual Federal Funds target rate increases affecting our short term borrowings and the addition of two longer term FHLB advances later in 2016. Short term borrowing rates have continued to gradually increase after that date. We utilized only short term FHLB advances in 2015 and the first half of 2016. In the second half of 2016 we added $20.0 million consisting of $10.0 million in two-year and $10.0 million in four-year fixed rate advances, averaging 1.11%, to lock in those rates in anticipation of further market rate increases.

Interest paid on checking, money market and savings accounts increased $87,000, or 12.9%, to $760,000 for the nine months ended September 30, 2017 from $673,000 for the nine months ended September 30, 2016. The average rate we paid on such deposit accounts increased seven basis points to 0.80% for the nine months ended September 30, 2017 from 0.73% for the nine months ended September 30, 2016 and the average balance increased $3.7 million, or 3.0%, to $127.2 million for the nine months ended September 30, 2017 from $123.5 million for the nine months ended September 30, 2016. The increase in checking, savings and money market deposits is primarily due to maturing time deposit customers preferring not to lock into term deposits, and growth from new and existing Arizona customers. The average rates we pay on these accounts is considerably higher in our Arizona market.

***Net Interest Income.*** Net interest income increased $1.5 million or 16.8%, to $10.1 million for the nine months ended September 30, 2017 from $8.7 million for the nine months ended September 30, 2016, as a result of a higher balance of net interest-earning assets and a more favorable mix, partially offset by a lower net interest rate spread. Our average net interest-earning assets increased by $20.2 million, or 41.0%, to $69.3 million for the nine months ended September 30, 2017 from $49.2 million for the nine months ended September 30, 2016 due primarily to organic growth. Our net interest rate spread declined by 13 basis points to 4.11% for the nine months ended September 30, 2017 from 4.24% for the nine months ended September 30, 2016. We carried 85.8% of our average interest-earning assets in loans, our highest yielding asset, for the nine months ended September 30, 2017 compared to 82.9% in loans for the comparable period in 2016. This repositioning of our asset portfolio was achieved principally through organic loan growth. Our cost of borrowings increased to 1.02% for the nine months ended September 30, 2017 from 0.56% for the nine months ended September 30, 2016 due to the increase in short term interest rates following the 25 basis point increases in the target Federal Funds rate in December 2016, March 2017, and June 2017 and the additional $20.0 million in long-term, higher rate, borrowings.

***Provision for Loan Losses.*** We recorded a provision for loan losses of $550,000 for the nine months ended September 30, 2017, compared to $306,000 for the nine months ended September 30, 2016. In addition, $20,000 in recoveries of previously charged-off balances were received during the nine months ended September 30, 2017 compared to $118,000 in the nine months ended September 30, 2016. In the nine months ended September 30, 2017, the allowance for loan losses increased $867,000, or 39.4%, and gross loans held for investment grew $46.7 million, or 21.0%.

***Noninterest Income.*** Noninterest income increased $574,000, or 7.2%, to $8.5 million for the nine months ended September 30, 2017 from $7.9 million for the nine months ended September 30, 2016 primarily due to a higher volume of loan sales and related gains, and a decrease in loss on sale and impairments of other real estate.

Gain on sale of loans increased $542,000, or 7.2%, to $8.1 million for the nine months ended September 30, 2017 from $7.5 million for the nine months ended September 30, 2016 as the Company has continued to expand its secondary mortgage loan operation.

During the nine months ended September 30, 2017, we sold $188.2 million of mortgage loans and recognized gains of $7.8 million compared to $188.7 million of mortgage loan sales during the nine months ended September 30, 2016 for gains of $7.0 million. Mortgage sales gain premiums vary from period to period based upon the mix of government FHA and VA loans to conventional loans, geographic markets and market interest rates, specifically 10-year Treasury rates. Sales gains include fair value adjustments for interest rate lock commitments and loans held for sale. As discussed above, in September 2017 we began originating and selling mortgage loans under mandatory delivery sales commitments. We also began entering into counterparty trades with similar notional amounts designed to react inversely to market interest rate movements to reduce our interest rate risk on mandatory delivery loans. The implementation of those activities represented $668,000 of the gain on sale of loans for the nine months ended September 30, 2017.

During the nine months ended September 30, 2017, we sold $2.9 million of SBA loans for a gain of $273,000, compared to $5.5 million of sales during the nine months ended September 30, 2016 for gains of $504,000.

We incurred no loss on sale or impairments of other real estate in the nine months ended September 30, 2017 compared to $90,000 in the nine months ended September 30, 2016.

***Noninterest Expense.*** Noninterest expense increased $1.5 million, or 9.6%, to $16.7 million for the nine months ended September 30, 2017 from $15.2 million for the nine months ended September 30, 2016 due primarily to higher salaries and benefits, data processing fees and advertising costs, partially offset by lower professional fees. The increase in salaries and benefits expense resulted primarily from the expansion of our mortgage banking program. Average assets for the nine months ended September 30, 2017 were 18.7% larger than the nine months ended September 30, 2016.

***Income Tax Expense.*** Income tax expense increased $449,000 to $491,000 for the nine months ended September 30, 2017 compared to $42,000 for the nine months ended September 30, 2016. The Company had net operating loss carry-forwards from prior periods which offset income for the nine months ended September 30, 2016 and a 100% reserve against deferred tax assets; therefore, 2016 income tax expense consisted only of Federal alternative minimum tax and state tax expense. In December 2016 the reserve against deferred tax assets was removed and tax expense starting with the first quarter of 2017 was recorded at more common effective tax rates.

### Asset Quality

We review loans on a regular basis, and place loans on nonaccrual status when either principal or interest is 90 days or more past due. In addition, we place loans on nonaccrual status when we do not expect to receive full payment of interest or principal. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is reversed from interest income. Once a loan is placed on nonaccrual status, the borrower must generally demonstrate at least six consecutive months of payment performance before the loan is eligible to return to accrual status.

***Non-Performing Loans and Non-Performing Assets.*** The following table sets forth information regarding our non-performing assets. As of September 30, 2017 and December 31, 2016, we had no troubled debt restructurings. Troubled debt restructurings include loans for which either a portion of interest or principal has been forgiven, or for loans modified at interest rates materially less than current market rates.

*(Dollars in thousands)*

| Nonaccrual loans Real estate loans: | At September 30, 2017 | At December 31, 2016 |
| --- | ---: | ---: |
| One- to four-family residential real estate | **$657** | $649 |
| Commercial real estate | **3,576** | 3,719 |
| Commercial and industrial | **1,569** | 1,600 |
| Consumer and other | **-** | - |
| Total nonaccrual loans | **5,802** | 5,968 |
| Other real estate (ORE) | **-** | - |
| Total nonperforming assets | **$5,802** | $5,968 |
| Ratios: |  |  |
| Nonperforming loans to gross loans held for investment | **2.15%** | 2.44% |
| Nonperforming assets to total assets | **1.60%** | 1.81% |
| Nonperforming assets to gross loans held for investment and ORE | **2.15%** | 2.44% |

The nonperforming asset ratios decreased due to the $166,000 decrease in nonperforming loans along with increases of 10.4% in gross loans held for investment and total assets.

Interest income that would have been recorded for the nine months ended September 30, 2017, had nonaccruing loans been current according to their original terms amounted to $256,000. We recognized $2,700 interest income on these nonaccrual loans for the nine months ended September 30, 2017.

At September 30, 2017, we had no loans that were not currently classified as nonaccrual, 90 days past due or troubled debt restructurings where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with existing loan repayment terms and that could result in disclosure as non-accrual, 90 days past due or troubled debt restructurings.

***Allowance for Loan Losses.*** The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management’s periodic evaluation of the adequacy of the allowance is based on the current level of net loan losses, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions.

The following table sets forth activity in our allowance for loan losses for the periods indicated.

*(Dollars in thousands)*

|  | Nine Months Ended September 30, 2017 | 2016 |
| --- | ---: | ---: |
| Balance at beginning of period | **$2,506** | $1,894 |
| Provision for loan losses | **550** | 306 |
| Charge-offs: |  |  |
| One- to four-family residential real estate loans | **(9)** | (118) |
| Commercial real estate loans | **-** | - |
| Commercial and industrial loans | **-** | - |
| Consumer and other loans | **-** | - |
| Total charge-offs | **(9)** | (118) |
| Recoveries: |  |  |
| One- to four-family residential real estate loans | **19** | 2 |
| Commercial real estate loans | **1** | 116 |
| Commercial and industrial loans | **-** | - |
| Consumer and other loans | **-** | - |
| Total recoveries | **20** | 118 |
| Net recoveries | **11** | - |
| Balance at end of period | **$3,067** | $2,200 |
| ALLL to nonperforming loans | **52.86%** | 132.32% |
| ALLL to total gross loans | **1.13%** | 0.99% |
| ALLL to total gross loans less acquired loans | **1.26%** | 1.19% |
| Net recoveries to average loans outstanding during the period | **0.01%** | 0.00% |

The allowance for loan losses to nonperforming loans ratio decreased due to the 373.0% increase in nonperforming loans from September 2016 to September 2017 compared to the 39.4% increase in the allowance for loan losses. The allowance for loan losses to total gross loans ratio increased due to a 21.1% increase in total gross loans compared to the 39.4% increase in the allowance for loan losses.

### Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, FHLB borrowings, loan repayments and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits with other banks and short- and intermediate-term securities.

We believe that we have enough sources of liquidity to satisfy our short-term liquidity needs as of September 30, 2017.

Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2017, cash and cash equivalents totaled $34.9 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $26.7 million at September 30, 2017. In addition, at September 30, 2017, we had the ability to borrow an additional $69.7 million from the FHLB of Dallas. On that date, we had $67.0 million of advances outstanding. The Bank also had two lines of credit available with other financial institutions of $6.0 million and $9.8 million, respectively.

At September 30, 2017, we had $34.3 million in portfolio loan commitments outstanding, and an additional $27.3 million in commitments to originate and sell mortgage loans. In addition, we had $11.6 million in unused lines of credit and $125,000 commitment issued under standby letters of credit. Time deposits due within one year as of September 30, 2017 totaled $36.4 million, or 15.2% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other time deposits and FHLB advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the time deposits due on or before September 30, 2018. We believe, however, based on past experience that a significant portion of our time deposits will remain with us, either as time deposits or as other deposit products. We have the ability to attract and retain deposits by adjusting the interest rates offered.

We have no material commitments or demands that are likely to affect our liquidity other than set forth above. In the event loan demand were to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we would access our borrowing capacity with the FHLB of Dallas or the other financial institutions, or increase our deposits by offering higher interest rates.

Our primary investing activities are the origination of loans and the purchase of securities. During the nine months ended September 30, 2017, we originated $82.4 million of loans held for investment and $184.5 million of mortgage loans held for sale, compared to $80.4 million of loans held for investment and $203.9 million of mortgage loans held for sale during the nine months ended September 30, 2016. In the nine months ended September 30, 2017 and 2016, we purchased $0 and $8.5 million of securities, respectively. We have not purchased any whole loans in recent periods.

Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced net increases of $11.0 million and $18.5 million in total deposits for the nine months ended September 30, 2017 and 2016, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits so that we are competitive in our market area.

FHLB advances increased $17.0 million and $36.0 million for the nine months ended September 30, 2017 and 2016, respectively. In 2017 we have been funding our loans held for sale and some portfolio loan growth with short-term FHLB borrowings. At September 30, 2017 loans held for sale were $10.5 million and FHLB borrowings were $67.0 million. During the nine months ended September 30, 2016, we were able to utilize proceeds from FHLB advances and excess liquid funds held at December 31, 2016 to fund new loan originations.

Bancorp 34, Inc. is a separate legal entity from the Bank and must provide for its own liquidity to pay any dividends to stockholders, to repurchase its common stock, and for other corporate purposes. Bancorp 34, Inc.’s primary source of liquidity is dividend payments it may receive from the Bank. At September 30, 2017, Bancorp 34, Inc. (on an unconsolidated basis) had liquid assets of $6.9 million held in deposit accounts at Bank 34.

The net proceeds from the “second-step” stock offering increased our liquidity and capital resources. Over time, the initial level of liquidity will be reduced as net proceeds from the stock offering are used for general corporate purposes, including funding loans. Our financial condition and results of operations will be enhanced by the net proceeds from the stock offering, which will increase our net interest-earning assets and net interest income. However, due to the increase in equity resulting from the net proceeds raised in the stock offering, as well as other factors associated with the stock offering, our return on equity has been adversely affected by the stock offering.

The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2017 and December 31, 2016, Bank 34 exceeded all regulatory capital requirements. Bank 34 is considered “well-capitalized” under regulatory guidelines.

## Controls and procedures

As filed, 928 characters.

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended) as of September 30, 2017. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Executive Vice President and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

During the quarter ended September 30, 2017, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Filed Nov 14, 2017.
Source: SEC EDGAR, the filing index for accession 0001437749-17-019265. Last ingested by Listed: Oct 24, 2026, 15:07 ET. No prices; not investment advice.